Unfair but balanced commentary on tax and budget policy, contemporary U.S. politics and culture, and whatever else happens to come up

Tuesday, October 06, 2015

Stop using the Gini coefficient!

I
have felt for a while that statistical measures of aggregate inequality, such
as the Gini coefficient, are not very informative because they agglomerate two
different issues: high-end inequality and low-end inequality.

"According
to an old joke, a statistician whose head was on fire, while his feet were
encased in a block of ice, reported that, on average, he was very
comfortable. Less well-known, however, is the kinship of a sort between
this poor fellow and the Italian statistician Corrado Gini, who not only
devised the famous Gini coefficient, but urged its use in measuring a given
society’s aggregate income or wealth inequality.

"The problem
Gini missed relates to interpretation, rather than to measurement. Under
the Gini coefficient, extreme inequality at both the top and the bottom of the
social scale will not statistically offset each other, giving us a false
reading of zero aggregate inequality, along the lines of the fire-and-ice example.
Instead, each will raise the quantum of inequality that the measure
detects. However, the coefficient still has the defect of amalgamating
two normatively distinct phenomena in a single measure.

"Low-end
inequality matters because it indicates that some people are worse-off than the
rest of us. Basic human beneficence indicates trying to help such
individuals. To be similarly concerned about high-end inequality, from
the standpoint of beneficence – which would oppose making those at the top
worse-off as an end in itself – one needs to make the case that it is bad for
everyone else. I myself am among those who believe that the extraordinary
rise, in recent decades, of the top 0.1 percent has indeed had harmful effects
on the remaining 99.9 percent. Yet whether those of us who believe this
are right or wrong, both the main issues raised by high-end inequality and the
main fiscal policy (and other) instruments that one might use in addressing it,
are very different than those associated with addressing low-end
inequality."

The problems with
using Gini were most recently brought to mind by recent discussion of a paperby Bill Gale,
Melissa Kearney, and Peter Orszag which asked "how much of a reduction in income
inequality would be achieved from increasing the top individual tax rate to as
much as 50 percent. We calculate the resulting change in income inequality
assuming an explicit redistribution of all new revenue to households in the
bottom 20 percent of the income distribution. The resulting effects on overall
income inequality are exceedingly modest."

One
issue raised here is that raising the ordinary income rate can't do anything
about all economic income that isn't subject to this rate, whether because it
is treated as capital gains or remains unrealized. Likewise, taxing inheritance
is not part of the exercise - whereas, whether doing so is a good idea or not,
it's clearly more closely related than annual taxable income to all of the
Piketty issues.

More
on the Gini front, however, here is part of John Quiggin's response, which is very like-minded to my view
of the topic:

"What does
this [i.e., the Gale-Kearney-Orszag finding] mean? Two things:

"(i) As is
well known, the Gini coefficient is a lousy measure of income inequality, much
more sensitive to the middle of the income distribution than to the tails.
[Note: as Quiggin acknowledges, Gale et al look at considerably more than just
Gini - I am telescoping the discussion here.]

"(ii) The
proposed redistribution would substantially improve the welfare of the poor,
with most of the burden being borne by taxpayers in or near the top 0.1 per
cent.

"It’s
obvious, as the authors note, that the 90-50 measure won’t change, since
neither group is affected (there’s no simulation of behavioral responses which
might have indirect effects). But, since the 99th percentile income is very
close to $400k, there’s very little impact on this group either. But the tax, as
modeled, raises a lot of money from the ultra-rich incomes. As a result,
distributing the proceeds at the bottom of the distribution raises incomes
substantially, which explains the big changes in the 90-10 and 99-10 ratios.

"The real
lesson to be learned here, one I came to pretty slowly myself is that old-style
measures looking at quintiles or even percentiles of the income distribution
are no longer very relevant. The real question, in the economy of Capital in
the 21st Century is how much should go to the ultra-rich."

Or at least, I
would say, that's the real question insofar as one's interest is high-end
inequality in particular. (With no adverse implications for the relevance of
low-end inequality.)

About Me

I am the Wayne Perry Professor of Taxation at New York University Law School. My research mainly emphasizes tax policy, government transfers, budgetary measures, social insurance, and entitlements reform. My most recent books are (1) Decoding the U.S. Corporate Tax (2009) and (2) Taxes, Spending, and the U.S. Government's March Toward Bankruptcy (2006). My other books include Do Deficits Matter? (1997), When Rules Change: An Economic and Political Analysis of Transition Relief and Retroactivity (2000), Making Sense of Social Security Reform (2000), Who Should Pay for Medicare? (2004), Taxes, Spending, and the U.S. Government's March Towards Bankruptcy (2006), Decoding the U.S. Corporate Tax (2009), and Fixing the U.S. International Tax Rules (forthcoming). I am also the author of a novel, Getting It. I am married with two children (boys aged 16 and 19) as well as four (!) cats. For my wife Pat's quilting blog, see Patwig’s Blog.